The Italian Solution: A Dissent

Yesterday a group of economists issued a petition to the (new, Berlusconi-free) Italian government. You can read it here. They set out what is mostly good advice based on the premise that Italy should remain in the EMU. Many of my friends signed the petition, but I had to decline. Here is the text of my response to them:

“Dear Friends: I share your concern about the grave situation in Italy. I support much of the petition. In particular, I agree that the ECB must stand ready to buy government debt – indeed, it should announce its intention to drive interest rates for government debt of every member below 3%, and keep buying until it achieves the goal. I also agree that fiscal contraction must be abandoned. There are however three points discussed in the petition on which my views diverge:

a) The solution to the Euro crisis is not to be found in SDRs and the IMF. The ECB can immediately end the problem with government debt. No external help is required, nor should it be sought.

b) The petition should not call for stabilizing debt ratios at current levels. With an ECB backstop, the debt ratio disappears as a matter for concern. It is impossible to say in advance what debt ratio will be required for Italy (and others) to grow back toward prosperity and full employment. There is no point in tying government’s hand to any particular debt ratio.

c) The petition’s statement about “freeing resources” to direct them to promoting full employment is confused. It seems to be based on some loanable funds model. Europe’s problem is that it has far too many “free resources” that are idle – unused capacity: labor, factories – so it does not need to “free” any more. If the petition is discussing “financial resources,” then these are never a scarce resource that needs to be “freed.” I also do not like the statement about taxes. Of course tax evasion should be reduced – but that is a matter of fairness, not “financial resources.”

The first of these points is admittedly minor. The final two points are important. I would like to join my friends in signing the petition but I regret to say that I cannot support arbitrary debt limits (once there is a backstop – and without the backstop then all euro-using governments must reduce their debt ratios tremendously, perhaps to no more than 15% to 20% of GDP), nor a confusing statement on the necessity of freeing resources.”